Deferred tax on temporary differences (incl. Zakat interaction)

Many KSA retail groups operate under a mixed Zakat/income-tax regime driven by ownership structure (Saudi/GCC ownership subject to Zakat, foreign ownership subject to income tax on the corresponding share), and it is a critical, sometimes misunderstood point that Zakat is calculated on a Zakat base rather than taxable profit, so it generally falls outside IAS 12 and entities generally do not recognise deferred tax for the Zakat portion (some entities have an established policy to the contrary, which must then be applied consistently and disclosed). Deferred tax under IAS 12 only arises on temporary differences attributable to the income-tax-paying portion of the business, commonly from inventory provisions, right-of-use assets and lease liabilities recognized under IFRS 16, and accelerated tax depreciation on PP&E versus book depreciation. Conflating the two regimes - either applying IAS 12 mechanics to the Zakat base, or omitting deferred tax on the taxable portion - leads to materially incorrect tax expense, deferred tax balances, and effective tax rate reconciliations, which are heavily scrutinized by auditors and ZATCA given the prevalence of mixed ownership structures in Saudi retail.

What is the ownership split between Zakat-payer and income-tax-payer shareholders, and is it applied consistently to segregate the two regimes? Do carrying amounts of inventory provisions, right-of-use assets/lease liabilities, or fixed assets differ from their tax bases in a way that creates temporary differences? Are deferred tax assets on losses or provisions supportable by credible forecasts of future taxable profit, and is deferred tax computed only on the income-tax-attributable portion, not the Zakat portion?

1. Determine the ownership split between Zakat-payer shareholders and income-tax-payer shareholders (e.g., 80% Saudi/GCC-owned Zakat base, 20% foreign-owned income-tax base) as the starting point for segregating the two regimes.
2. Confirm that Zakat is accounted for as a current-period provision/liability based on the Zakat base (broadly built up from equity, retained earnings, and adjusted net income items). Because Zakat is calculated on a Zakat base rather than taxable profit, it generally falls outside IAS 12 and deferred tax is generally not recognised for the Zakat portion; confirm the entity's Zakat and tax profile, and any established policy, before concluding.
3. For the income-tax-paying portion only, identify temporary differences between the tax base and carrying amount of assets/liabilities - typically inventory provisions (tax-deductible only on write-off/sale, not on booking the provision), IFRS 16 ROU assets and lease liabilities (different depreciation/interest pattern versus tax-deductible rent expense timing), and PP&E (accelerated tax depreciation versus straight-line book depreciation).
4. Recognize a deferred tax liability for taxable temporary differences and a deferred tax asset for deductible temporary differences on the income-tax portion only, subject to the initial recognition exception for transactions (other than business combinations) that affect neither accounting nor taxable profit and do not give rise to equal taxable and deductible temporary differences (so the exception does not apply to a lease's right-of-use asset and lease liability at commencement), and subject to assessing recoverability (probable future taxable profit) for deferred tax assets.
5. Where the group reports on a consolidated basis, ensure deferred tax is computed and disclosed only in proportion to the income-tax-attributable ownership percentage, not on 100% of the temporary difference.
6. Reassess the ownership split and resulting Zakat/tax allocation whenever shareholding structure changes, as this changes the population of temporary differences subject to IAS 12.

Deferred tax balances are measured at the tax rates expected to apply when the temporary difference reverses, applied only to the income-tax-attributable portion of the relevant temporary difference (not the Zakat portion), based on tax rates/laws enacted or substantively enacted by the reporting date. Deferred tax is not discounted. Deferred tax assets are recognised only to the extent that it is probable that sufficient future taxable profit (of the income-tax-paying portion) will be available to utilise the deductible temporary difference, reassessed at each reporting date. The Zakat provision, by contrast, is measured based on the current-period Zakat base under ZATCA rules and is a current liability, not a deferred balance; under the generally followed position it is not measured using deferred tax mechanics such as tax-rate-driven temporary difference reversals, unless the entity has an established, disclosed policy to the contrary.

Separate presentation of the current Zakat provision and any deferred tax asset/liability, with no commingling of the two; reconciliation between accounting profit and the tax expense/effective rate for the income-tax-paying portion, distinct from the Zakat charge; breakdown of deferred tax assets and liabilities by major category of temporary difference (inventory provisions, ROU/lease liabilities, PP&E); disclosure of the ownership-based allocation methodology between Zakat and income tax; unrecognized deferred tax assets and the reason for non-recognition, if any; description of the basis on which the Zakat provision is computed (Zakat base per ZATCA regulations) clearly distinguished from IAS 12 income tax disclosures; any uncertain tax/Zakat positions and related contingencies

• Recognizing deferred tax on the Zakat-attributable portion of temporary differences by treating Zakat as if it were an income tax under IAS 12, without an established and disclosed policy supporting that treatment
• failing to recognize any deferred tax at all on the income-tax-paying portion because the group is '
• mostly Zakat-payer'
• applying the full 100% temporary difference to deferred tax computation instead of only the income-tax ownership percentage
• overlooking IFRS 16 ROU/lease liability timing differences as a deferred tax source because they net to a similar amount initially (the P&
• L pattern differs even if opening balances are equal)
• not reassessing the Zakat/tax split when ownership percentages change during the year
• presenting the Zakat provision within the income tax expense line without clear separate disclosure